Rights Issues – Back in Fashion?

Until recently, most people would probably have agreed that (with one or two notable exceptions) there had not been any significant rights issues by UK listed companies since the early 1990s. However, with the ground-breaking £5.9 billion rights issue announced by BT plc in May 2001 and then those undertaken recently by European insurers such as Legal & General and Zurich, there are signs that the rights issue is coming back into vogue as a means of raising fresh capital.

There are a number of commercial reasons why companies are now announcing rights issues. However, a "common thread" is the need to address certain legal issues which arise. This note contains a refresher on some key legal issues and a reminder of the principal stages in a rights issue timetable.

A rights issue has four basic elements:

• existing shareholders are offered the right to subscribe new shares in proportion (more or less) to their existing shareholdings;
• the new shares will be subscribed in cash and are typically offered at a discount to the market price of the shares;
• a shareholder can realise value by selling his rights to subscribe new shares "nil paid"; and
• a shareholder can also receive cash for taking no action at all, if the shares that he could have subscribed are sold in the market on his behalf at a price which exceeds the subscription price offered to him.

Rights issues are also usually (but not always) underwritten by the investment bank(s) advising the corporate issuer. The underwriter’s obligation is to subscribe any new shares which existing shareholders do not take up and which cannot then be sold into the market by the investment bank to third parties. In certain cases, however, a decision is taken not to have the rights issue underwritten because the extent of the discount to the open market price offered is deemed so attractive as effectively to guarantee the success of the new issue.

Clearly, underwriting is an important commercial issue for corporates and financial advisers alike to address. The longer the period between announcing the rights issue and expiry of the period for "nil paid" dealings (see below), the more expensive underwriting can be expected to be.

• As a rights issue involves the issue of new shares, it is important to check that the issuer has sufficient authorised but unissued share capital and that the directors are authorised under Section 80 Companies Act 1985 to issue that share capital. Otherwise, it would be necessary to call an extraordinary general meeting to pass appropriate shareholder resolutions.
• "Pre-emption rights" under Section 89 Companies Act 1985 – issues of new shares must be offered to existing shareholders first, to avoid dilution of their existing shareholdings. This can cause particular problems when a company has overseas shareholders in certain countries (such as Canada and the US) where offering the rights issue shares may involve compliance with strict securities laws. Convertible securities and shareholders’ fractional entitlements to new shares can also give rise to difficulties. Whilst in the case of overseas shareholders it may be possible to avoid the problem by making the offer of new shares through a statutory notice in the London Gazette (the so-called "Gazette route"), in many cases companies prefer to disapply the statutory pre-emption rights through a shareholder resolution under Section 95 Companies Act 1985.
• A listed company must also have regard to the guidelines issued by the Investment Protection Committees to protect the interests of institutional shareholders. These, together with certain of the Listing Rules issued by the UKLA, restrict the amount of new shares which can be offered in a rights issue and the discount at which they may be offered, unless the new shares are first offered to existing shareholders broadly in proportion to their shareholdings.

The various steps in a typical rights issue would usually be as follows:

• "Launch Date" agreed by the company and its financial adviser. Issues which would raise over £20 million must be notified to the Bank of England, which warns if there is a risk of a timing conflict with another rights issue.
• The company and its financial adviser prepare the various documents which will be needed. These include a press announcement; a circular to shareholders (which will need to be a prospectus if, for example, the rights issue will result in an increase of 10% or more in the listed company’s share capital); provisional allotment letter, or PAL, the document representing a shareholder’s right to subscribe new shares; and (where necessary) an underwriting agreement between the company and its financial adviser. ¦
• Application is made to the London Stock Exchange for listing of the new shares, the rights issue is priced and approved by the company’s board and relevant documents are signed in escrow.
• Launch Date occurs.
• The rights issue circular is sent to shareholders. Any required notice is placed in the London Gazette. The PALs are also sent to shareholders, either with the circular or, where a shareholder general meeting is required, following passing of the relevant shareholder resolutions.
• Once the PALs have been sent to shareholders, the new shares will be admitted to the Official List and dealings will commence "nil paid" in the new shares. Dealing in "nil paid" rights will continue for a minimum of 21 days and those rights should have a value in the market unless the issue has been poorly received.
• Once the "nil paid" dealings period has ended, the financial adviser (acting through the broker) normally has two business days to sell any shares not taken up, otherwise the underwriter (or any sub-underwriters) will subscribe those shares itself. This means that where a rights issue is underwritten, the company can be sure that it will raise a certain amount of money.
• The Listing Rules require an announcement to be made without delay of the result of the new issue. However, where there is an underwriting arrangement, the issuer may delay notifying the result until the obligation of the underwriter to take or find others to take the shares is finally determined or lapses.

Companies should consider at the outset the following alternatives to a rights issue:

• Open Offer – an open offer is an offer of new shares to shareholders in proportion to their existing shareholdings, with the discount at which they are offered limited to no more than 10% and no arrangements made (unlike on a rights issue) for shareholders to deal in "nil paid" rights. Open offers may be attractive to issuers because the discounts to the market price are usually less but they are less flexible for shareholders and the Investment Protection Committees have stated that above certain thresholds of size or discount they would prefer to see rights issues.
• Cash Placing – this is a "quick and dirty" alternative to a rights issue. Shares are placed with subscribers found by the financial adviser in return for an agreed commission. As the shares being placed will not be offered to existing shareholders in proportion to their existing shareholdings, the statutory preemption rights will need to have been disapplied to the extent of the placing and (as indicated above) the Investment Protection Committees have issued guidelines on the extent to which this can be done, to protect the position of institutional shareholders.
• Vendor Placing – this can provide a means of funding an acquisition. The target business is sold for shares in the purchaser but those shares are placed by the purchaser’s financial adviser and the resulting cash paid to the vendors of the business. Vendor placings are now rare because the accounting advantages of using them are no longer available. As technically the new shares are not issued for cash (they are issued in exchange for the target business instead), the preemption rules in section 89 Companies Act 1985 do not apply but the Investment Protection Committees require a clawback to enable existing shareholders to participate if the size or discount of the new issue exceeds certain thresholds.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.